Chapter 3 Financial Analysis
3. Profitability ratios (LO2) Polly Esther Dress Shops, Inc., can open a new store that will do an annual sales volume of $960,000. It will turn over its assets 2.4 times per year. The profit margin on sales will be 7 percent. What would net income and return on assets (investment) be for the year?
33. Solution: Polly Esther Dress Shops, Inc.
14. Du Pont system of analysis (LO3) The King Card Company has a returnonassets (investment) ratio of 12 percent.
a. If the debttototalassets ratio is 40 percent, what is the return on equity?
b. If the firm had no debt, what would the returnonequity ratio be?
314. Solution: King Card Company
^{a. }
b. The same as return on assets of 12% because with no debt, the denominator would be 1.
15. Du Pont system of analysis (LO3) Using the Du Pont method, evaluate the effects of the following relationships for the Lollar Corporation.

Lollar Corporation has a profit margin of 5 percent and its return on assets (investment) is 13.5 percent. What is its assets turnover ratio?

If the Lollar Corporation has a debttototalassets ratio of 60 percent, what would the firm’s return on equity be?

What would happen to return on equity if the debttototalassets ratio decreased to 40 percent?
315. Solution
^{a. }
^{b. }
315. (Continued)
^{c. }
18. Average collection period (LO2) A firm has sales of $1.2 million, and 10 percent of the sales are for cash. The yearend accounts receivable balance is $180,000. What is the average collection period?
(Use a 360day year.)
318. Solution:
19. Average daily sales (LO2) The Chamberlain Corporation has an accounts receivable turnover equal to 12 times. If accounts receivable are equal to $90,000, what is the value for average daily credit sales?
319. Solution: Chamberlain Corporation
To determine credit sales, multiply accounts receivable by accounts receivable turnover.

Trend analysis (LO4) Jodie Foster Care Homes, Inc., shows the following data:
Year Net Income Total Assets Stockholders’ Equity Total Debt
2007 $118,000 $1,900,000 $ 700,000 $1,200,000
2008 131,000 1,950,000 950,000 1,000,000
2009 148,000 2,010,000 1,100,000 910,000
2010 175,700 2,050,000 1,420,000 630,000
a. Compute the ratio of net income to total assets for each year and comment on the trend.
b. Compute the ratio of net income to stockholders’ equity and comment on the trend. Explain why there may be a difference in the trends between parts a and b.
327. Solution:
Jodie Foster Care Homes, Inc.
a.
2007 $118,000/$1,900,000 = 6.21%
2008 $131,000/$1,950,000 = 6.72
2009 $148,000/$2,010,000 = 7.36
2010 $175,700/$2,050,000 = 8.57
Comment: There is a strong upward movement in return on assets over the four year period.
b.
2007 $118,000/$700,000 = 16.86%
2008 $131,000/$950,000 = 13.79
2009 $148,000/$1,100,000 = 13.45
2010 $175,700/$1,420,000 = 12.37
Comment: The return on stockholders’ equity ratio is going down each year. The difference in trends between a and b is due to the larger portion of assets that are financed by stockholders’ equity as opposed to debt.
327. (Continued)
Optional: This can be confirmed by computing total debt to total assets for each year.
2007 63.2%
2008 51.3
2009 45.3
2010 30.7

Trend analysis (LO4) Quantum Moving Company has the following data. Industry information also is shown.
Industry Data on
Company Data Net Income/Total Assets
Year Net Income Total Assets
2008 $350,000 $2,800,000 11.5%
2009 375,000 3,200,000 8.4
2010 375,000 3,750,000 5.5
Industry Data on
Year Debt Total Assets Debt/Total Assets
2008 $1,624,000 $2,800,000 54.1%
2009 1,730,000 3,200,000 42.0
2010 1,900,000 3,750,000 33.4
As an industry analyst comparing the firm to the industry, are you likely to praise or criticize the firm in terms of:
a. Net income/Total assets.
b. Debt/Total assets.
328. Solution:
Quantum Moving Company
a. Net income/total assets

Year

Quantum Ratio

Industry Ratio

2008

12.5%

11.5%

2009

11.7%

8.4%

2010

10.0%

5.5%

Although the company has shown a declining return on assets since 2008, it has performed much better than the industry. Praise may be more appropriate than criticism.
328. (Continued)
b. Debt/total assets

Year

Quantum Ratio

Industry Ratio

2008

58.0%

54.0%

2009

54.1%

42.0%

2010

50.7%

33.4%

While the company’s debt ratio is declining, it is not declining nearly as rapidly as the industry ratio. Criticism may be more appropriate than praise.
35. Using ratios to construct financial statements (LO2) The following information is from Harrelson, Inc.’s, financial statements. Sales (all credit) were $20 million for 2010.
Sales to total assets 2 times
Total debt to total assets 30%
Current ratio 3.0 times
Inventory turnover 5.0 times
Average collection period 18 days
Fixed asset turnover 5.0 times
Fill in the balance sheet:
Cash ______ Current debt ______
Accounts receivable ______ Longterm debt ______
Inventory ______ Total debt ______
Total current assets ______ Equity ______
Fixed assets ______ Total debt and equity ______
Total assets ______
335. Solution:
Harrelson Inc.
Sales/total assets = 2
Total assets = $20 million/2
Total assets = $10 million
Total debt/total asset = 30%
Total debt = $10 million x .3
Total debt = $3 million
Sales/inventory = 5.0x
Inventory = $20 million/5x
Inventory = $4 million
Average daily sales = $20 million/360 days
= $55,555.55 per day
Accounts receivable = 18 days × $55,555.56
= $1 million (or)
335. (Continued)
Fixed assets = $20 million/5x
= $4 million
Current assets = Total assets – Fixed assets
= $10 million  $4 million
= $6 million
Cash = Current assets – accounts receivable –
inventory
= $6 million – $1 million – $4 million
= $1 million
Current liabilities = Current assets/3
= $6 million/3
= $2 million
Longterm debt = Total debt – current debt
= $3 million – $2 million
= $1 million
Equity = Total assets – total debt
= $10 million – $3 million
= $7 million
335. (Continued)

Cash................

$ 1.0 million

Current debt.............

$ 2.0 million

Accounts receivable.....

$ 1.0

Longterm debt.............

$ 1.0

Inventory.........

$ 4.0

Total debt.......

$ 3.0

Total current assets............

$ 6.0

Equity.............

$ 7.0

Fixed assets.....

$ 4.0



Total assets.....

$10.0 million

Total debt and equity...........

$10.0 million

36. Comparing all the ratios (LO2) Using the financial statements for the Snider Corporation, calculate the 13 basic ratios found in the chapter.
SNIDER CORPORATION
Balance Sheet
December 31, 2010
Assets
Current assets:
Cash $ 50,000
Marketable securities 20,000
Accounts receivable (net) 160,000
Inventory 200,000
Total current assets $430,000
Investments 60,000
Plant and equipment 600,000
Less: Accumulated depreciation (190,000)
Net plant and equipment 410,000
Total assets $900,000
Liabilities and Stockholders’ Equity
Current liabilities
Account payable $90,000
Notes payable 70,000
Accrued taxes 10,000
Total current liabilities 170,000
Longterm liabilities:
Bonds payable 150,000
Total liabilities $320,000
Stockholders’ equity
Preferred stock, $50 per value 100,000
Common stock, $1 par value 80,000
Capital paid in excess of par 190,000
Retained earnings 210,000
Total stockholders’ equity 580,000
Total liabilities and stockholders’ equity $900,000

SNIDER CORPORATION

Income statement
For the Year Ending December 31, 2010

Sales (on credit)

$1,980,000

Less: Cost of goods sold

1,280,000

Gross profit

700,000

Less: Selling and administrative expenses

475,000*

Operating profit (EBIT)

225,000

Less: Interest expense

25,000

Earnings before taxes (EBT)

200,000

Less: Taxes

80,000

Earnings after taxes (EAT)

$ 120,000

*Includes $35,000 in lease payments.
336. Solution:
Snider Corporation
Profitability ratios
Profit margin = $120,000/$1,980,000 = 6.06%
Return on assets (investment) = $120,000/$900,000 = 13.3%
Return on equity = $120,000/$580,000 = 20.69%
Assets utilization ratios
Receivable turnover = $1,980,000/$160,000 = 12.38x
Average collection period = $160,000/$5,500 = 29.09 days
Inventory turnover = $1,980,000/$200,000 = 9.9x
Fixed asset turnover = $1,980,000/$410,000 = 4.83x
Total asset turnover = $1,980,000/$900,000 = 2.2x
Liquidity ratio
Current ratio = $430,000/$170,000 = 2.53x
Quick ratio = $230,000/$170,000 = 1.35x
Debt utilization ratios
Debt to total assets = $320,000/$900,000 = 35.56%
Times interest earned = $225,000/$25,000 = 9x
Fixed charge coverage = $260,000/$60,000 = 4.33x
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